Article about the
housing market problems and the Fed's response

Wanted:

Prime
Suspect of Housing Market Murder

Helen Mirren accepted her
Emmy award for best actress in the mini-series, "Prime Suspect" with
elegance and grace. Just the opposite of the tough detective
superintendent character she plays who tracks down murder suspects in
England. Who would Jane Tennison pick out as the prime suspect for the
murder of the U.S. housing market and the resulting gruesome credit
crunch?

Suspect No. 1 –
Phil Spector

No – sorry,
wrong case, wrong suspect. Spector has been on trial for the murder of a
guest at his home (the judge declared a mistrial this week), but Spector
has nothing to do with the subprime mortgage fallout and ensuing credit
crunch. O.J. Simpson, who stands accused of trying to "recover" his
sports memorabilia, is not the prime suspect either. If the crime
doesn't fit, you must acquit.

Suspect No. 2 –
Alan Greenspan

Says that he didn't catch on for a few years that subprime mortgages
could create a problem for the economy. As chairman of the Federal
Reserve, he let easy credit ride, which facilitated the housing bubble
and the subsequent implosion. Could liken his behavior to supplying the
gun to a rampaging murderer. Guilty of aiding and abetting, but he's not
necessarily the prime suspect.

Suspect No. 3 –
Angelo Mozilo

Angelo Mozilo, CEO of Countrywide Financial (largest mortgage company in
the United States), says he kept his staff writing subprime mortgages
day and night, because if they didn't, then home purchasers would just
find someone else to give them a low-quality mortgage. Company went from
writing 4.6% of its overall mortgages as subprimes and low-documentation
loans in 2004 to 8.7% in 2006. Guilty of greed and a poor business plan
but not murder.

Suspect No. 4 – S.
& P. and Moody's

Oh, whoops, say these rating agencies, we thought that once you sliced
up a BBB security thinly enough and packaged it with other more
desirable collateralized debt obligations that we could call it AAA. Did
we mislead anybody? Again, aiding and abetting but not a prime suspect.

Suspect No. 5 –
Goldman Sachs and other investment banks

Says that their investors wanted higher returns and that collateralized
debt obligations spiced up with subprime mortgages served the purpose.
And besides, they say, the rating agencies gave them an excellent
rating. Guilty of acting like a fence but not the prime murder suspect.

The True Prime
Suspect

All of these are worth a look as suspects, but the true prime suspect
has neither a first name nor a last. It's known as "social mood," and
its m.o. is "herding behavior." That's our real murderer, the one that
quashed the hopes and dreams of those who believed that house prices
would always go up. Social mood changed, and with it changed the idea of
what were smart financing moves to purchase a house. Suddenly, as house
prices began to fall and subprime mortgagees began to default on their
loans, the stick house built on low-quality mortgages seemed like a
really bad idea.

Who knew? When social mood
was positive, mortgage writers pushed people who couldn't really afford
a mortgage into believing they could. Then they sold the mortgages to
eager investment bankers who sliced them up into small packages of risk
and re-packaged them with less risky securities. Then the ratings
agencies gave their stamp of approval: AA? Why not AAA? And eager
investors who wanted higher returns bought them up.

But now the game is up.
When social mood turns from positive to negative, fear replaces greed,
and people begin to see the riskiness for what it is. When social mood
changes from positive to negative, markets turn from bullish to bearish.
And no one can stop it – not even the Fed.

"Like credit
inflation, credit deflation is in fact an intricate, interwoven
process, whose initial impetus is a change in social mood from
optimism toward pessimism. If you are still on the fence about this
idea, ask yourself: What changed in the so-called
“fundamentals” between June and August? The answer is: absolutely
nothing. Interest rates did not budge; there were no
indications of recession; there were no changes in bank lending
policies; there were no chilling government edicts.

"The only thing that
changed was people’s minds. One day sub-prime mortgages were a fine
investment, and the next day they were toxic waste. There was no
external cause of the change.… According to socionomic theory, the
stock market is a sensitive indicator of such changes in mood. This
is why The Elliott Wave Theorist has continually said that
the financial structure will hold up as long as the stock market
rises. A downturn occurred in mid-July, and its consequences in
terms of negative social mood are becoming swiftly evident.
Remember, C waves (see Elliott Wave Principle, Chapter 2)
are when optimistic illusions finally disappear and fear takes over.
Sounds like now." [Elliott Wave Theorist, September 2007]

How To Protect
Yourself

from
the Prime Suspect Who is Still on the Loose

Social mood has turned
ugly and is likely to continue its murderous rampage, leaving the
policymakers helpless. As analysts Steve Hochberg and Pete Kendall write
in The Elliott Wave Financial Forecast: "The Fed does not
"inject" liquidity; it only offers it. If nobody wants it, the inflation
game is over. The determinant of that matter is the market. When bull
markets turn to bear, confidence turns to fear, and a fearful people do
not lend or borrow at the same rates as confident ones. The ultimate
drivers of inflation and deflation are human mental states that the Fed
cannot manipulate."

What should you do to
protect yourself in this time of falling home prices, a powerless Fed
and a contracting economy? Bob Prechter wrote one of the best how-to
books. It's his business best-seller, titled, Conquer the Crash, How
To Survive and Prosper in a Deflationary Depression. You might want
to start there.

Editor's Note:
You can read a
FREE 9-page chapter from Conquer the Crash –
You will learn the implications of the massive credit expansion, what
triggers the change from boom times to recession, and more.

Susan C. Walker writes
for
Elliott Wave International, a market forecasting and technical
analysis company. She has been an associate editor with Inc. magazine, a
newspaper writer and editor, an investor relations executive and a
speechwriter for the Federal Reserve Bank of Atlanta. Her columns also
appear regularly on FoxNews.com.